Tax revenues are under relentless attack – the government needs to take action

Taxes are the price of a civilised society and without them no state can provide social infrastructure, alleviate poverty, subsidise corporations or rescue distressed banks. But tax revenues are under relentless attack and corporate ingenuity in avoiding taxes shows no limits.

Companies have become very adept at shifting profits to low/no tax jurisdictions through complex corporate structures, as shown by Google, Microsoft, Starbucks and others. They shift profits by using intragroup transfer pricing techniques, spurious royalty and management fee programmes.

They have also enabled their executives to avoid income taxes and National Insurance Contributions by paying in gold bars, fine wine, platinum sponge and routing the payments through trusts in offshore havens. The financial effects of this alchemy are hard to estimate with any precision, but various models suggest that up to £120 billion of tax revenues a year may be lost to the UK Treasury.

The UK government has done little to check organised tax. Former personnel of big accountancy firms, key players in the tax avoidance industry, sit on the HMRC board. Their personnel populate key working parties and committees.

Chasing tax avoiders is labour intensive, but since 2005, 34,000 jobs have gone from HMRC and another 10,000 are planned by 2015 under the government’s spending cuts. Inevitably, staff are demoralised. The public sector pay freezes have failed to reward staff and many have been poached by a rampant tax avoidance industry operated by major accountancy firms.

Occasionally, HMRC does take some cases to the courts but the sanctions against tax avoiders and designers of their schemes are ineffective.

For example, companies involved in tax avoidance continue to receive government contracts, subsidies and loans and also sit on HMRC board and working parties. Despite the courts declaring some of the avoidance schemes developed and marketed by accountancy firms to be unlawful, no firm has ever been prosecuted by HMRC.

There is an urgent need for action. The action should be based on principles of democracy and public accountability. The following would go some way towards stemming the tide:

1. Citizens can and should boycott the services of the organisations using and selling tax avoidance schemes.

2. All corporate tax returns and related correspondence should be publicly available. Advice related to purchase and implementation of tax avoidance schemes should be publicly available. This information would enable citizens to become the eyes and ears of the tax authorities and alert them of unusual transactions.

3. Businesses indulging in tax avoidance should not be able to second staff to government departments or sit on policymaking committees. They should not be allowed to exercise influence on public policymaking.

4. Governments need to invest in HMRC, for example more tax inspectors, to ensure that the predatory powers of tax avoiders are checked.

5. In February 2013, UK Treasury announced that its rules “will allow government departments to ban companies and individuals which take part in failed tax avoidance schemes from being awarded Government contracts”. So far, not a single tax avoider has been prevented from securing public contracts.

This needs to change. Those indulging in tax avoidance should not receive any publicly-funded loans, contracts and subsidies. Tax payment record of all bidders should be made publicly available.

6. The incorporation certificate of companies routinely involved in tax avoidance should be withdrawn. The privilege of limited liability should be reserved for organisations behaving in a socially responsible way.

7. When a court declares tax avoidance schemes used by a company to be unlawful, then directors should become personally liable for the tax payments and related legal; costs. Those marketing the unlawful scheme should face a fine of ten times the tax that was to be avoided.

8. All multinational corporations should publish a table showing their sales, profits, costs, employees and taxes paid in each country of their operations. This will help to see how profits have shifted away.

9. Most of tax avoidance revolves around artificial transactions. These should be challenged by enacting effective General Anti-Avoidance Rule (GAAR) so that sham transactions are rejected.  The current system is not effective. For example, it requires HMRC to seek permission form a panel of business elites before taking any action. HMRC need to be free from the clutches of big business.

10. A major reform of the current system of corporate taxation is needed. Firstly, companies are taxed at the place of their residence rather than where the economic activity took place. The fact that companies are integrated entities is not recognised for tax purposes. Thus, a company with 100 subsidiaries will be treated as 100 separate entities for tax purposes.

As companies are engaged in intragroup cross-border transfers of raw materials, finished goods and related services, a system was needed to estimate the value of such transfers. The solution was to agree on what is known as transfer pricing and intragroup transactions were to be valued at what the OECD calls “arm’s length” principle, or free-market market prices.

The above assumptions are now highly problematical. Independent arm’s length, transfer prices are hard to find. For example, just 10 corporations control 55 per cent of the global trade in pharmaceuticals; 67 per cent of the trade in seeds and fertilisers and 66 per cent of the global biotechnology industry.

The idea of taxing companies at their place of residence rather than where the economic activity takes place gave them a licence to create artificial entities and play-off one country against another and escape taxes altogether.

The issues can be addressed by a system known as “unitary taxation”. Under this a group of companies under common control, such as Google, would be treated as a single integrated company. Thus intragroup shifting of profits is negated. The total profit is then allocated to each country in accordance with a formula based on sales, number of employees and location of assets. Each country can then tax the resulting profits in accordance with its democratic mandate.

A variant of unitary taxation, known as Common Consolidated Corporate Tax Base (CCCTB), is being promoted by the European Union and deserves attention.